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Petroleum Market Commentary - September 3, 2012

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Prices Higher - More Negative Curve - Hurricanes - More Quantitative Easing?

During the two weeks ending August 31st, the spot month heating oil futures price increased by 7.70 cents per gallon (+2.49%) while the deferred months increased by 4 to 8 cents per gallon making the forward pricing curve higher and generally more negatively sloped over the next two years. The one year forward price ended the two weeks at a 10.03 cent (3.16%) discount to the spot price, from a discount of 6.75 cents (2.18%) two weeks prior.

The change in level and shape of the forward pricing curve indicates higher demand expectations and relatively less plentiful inventory levels with respect to supply and demand. Demand includes speculative demand which has increased and can be volatile. Supply disruption fears caused by the Iranian situation and relatively tight inventories with respect to the historical averages, have caused the front end of the curve to increase relative to the far end and for the curve to be more negatively sloped. This is due to the current lower inventories and the increased possibility of yet lower inventories caused by supply disruption from Iran in the short-term. Speculation increased significantly during the two weeks ended August 28th. Speculation is now over the one year moving average level.

The US Dollar was lower during the two week period which is positive for petroleum prices. The US stock market was also lower which is negative for petroleum prices. Petroleum demand for the week was higher which kept upward on prices. Overall petroleum inventories increased vs. expectations and vs. the five-year average keeping downward pressure on prices.

Speculation increased significantly during the two weeks ending August 28th. The statistical relationship between price and speculative levels remains high.

Weekly US petroleum demand decreased by 4.54% during the two weeks ending August 24th. Demand is down 2.14% vs. one year ago.

Prices were relatively stable during the period while shorter term hedging remains less attractive while longer term hedging remains relatively attractive in light of the historical range of prices. Spot prices are at the upper quintile of the 80 cent price range that we have seen over the past twelve months. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive. Entering new, longer-term hedges at these levels would involve relatively more competition with speculators for long futures positions as speculative levels have risen somewhat. This is a relative disadvantage to the hedger.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of August 31st.

Factors affecting the market on the period were:

During the week ended August 24th, total petroleum inventories increased by 3.14 million barrels vs. a five year average decrease of 0.88 million barrels and vs. an expected decrease of 3.00 million barrels. Inventories increased by 4.02 million barrels vs. the five year average. Total inventories stand at 691.8 million barrels, up from 688.7 million barrels at the end of the previous week. The five year average inventory is 697.1 million barrels, down from 698.0 at the end of the previous week. Current inventories are 0.76% smaller than the five year average up from -1.33% at the end of the previous week. Versus the five year average, inventories are now negative. While this is supportive of price, lower inventories are also due to lower demand which is negative for price.

As of August 28th, the net speculative long position in petroleum futures was 288,125,000 barrels up 19,421,000 barrels (+7.23%) from the previous week. The level of speculation has increased significantly in the past two weeks to levels last seen early May. This position represents 41.65% of domestic inventories. Speculation is 4.81% above its one year moving average and is 29.51% below the 52 week high level. Levels have returned to near the middle of the range that we have seen over the past two years. The corresponding spot month heating oil futures price on August 28th was 312.03 cents per gallon, down 0.40 cents from 312.43 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 91.47% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 83.67% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has strengthened in the past several months, and has become stronger as prices have been relatively more volatile. A linear regression analysis over the past 52 weeks shows that if speculation were zero and the market forces causing speculation evaporated, that the spot month heating oil futures price would be 231.28 cents per gallon or 80.75 cents per gallon less than current prices. The analysis would indicate that about 25.88% of current price is attributable to speculation and its underlying market rationale. The "would be" price has stabilized at the $2.31 level over the past several weeks and down slightly on the week.

The net speculative long position has been variable over the past year ranging between 70 million and 410 million barrels with an average of about 275 million barrels, an increased by roughly 2 million barrels on the week.

The graph below is three year history of speculative position levels.

Linwood Capital, LLC is an institutional fuel hedging management and consulting firm. Linwood creates and manages customized fuel hedging programs primarily for public clients on a nationwide basis.